Fairfax 2024

[SafetyinNumbers]

1 hour ago, PJM said:

Sorry to digress from the topic, does anyone know the tentative dates of Fairfax annual meeting in 2025 and related events. No announcement available on the website. Thanks

The Ben Graham Value Investing Conference (featuring Adam Waterous from Strathcona) is on April 8 so fair to assume Fairfax India AGM is on the 9th and Fairfax AGM is on the 10th.

 

https://www.ivey.uwo.ca/bengrahaminvesting/bgcvi-events/2025/04/2025-value-investing-conference/?utm_source=google&utm_medium=cpc&utm_term=&adpos=&gad_source=1&gbraid=0AAAAADvlxZdoVkuwEueSz6nVuNiFwIFLA&gclid=Cj0KCQiAlsy5BhDeARIsABRc6Zumbx_bDO6NwxclCd6RjwJ3HpXy-2KvnoA8_CZtX8dn3cq6AQTg6AUaAiEAEALw_wcB

[Dinar]

Renaissance Re on its conference call on November 7th: strong markets and rates are here to stay.

[gfp]

21 minutes ago, Dinar said:

Renaissance Re on its conference call on November 7th: strong markets and rates are here to stay.

 

That's impressive they know the future.  Super valuable skill to have

[Hoodlum]

1 hour ago, Dinar said:

Renaissance Re on its conference call on November 7th: strong markets and rates are here to stay.

 

It will be interesting to see if that position changes during the next 6 months.

[LC]

3 hours ago, Hoodlum said:

It will be interesting to see if that position changes during the next 6 months.

 

What makes you think the market is finally softening? 

[Munger_Disciple]

3 hours ago, gfp said:

 

That's impressive they know the future.  Super valuable skill to have

 

[Hoodlum]

1 hour ago, LC said:

 

What makes you think the market is finally softening? 

 

I just don't think we fully understand where the market may go throughout next year.  We just need to wait and see.

[LC]

Fair enough, I thought you may have worked in the industry and were seeing some early indicators.

[Dinar]

Here is an interesting anecdote.  I have an investment in a company that owns several dozen apartment buildings in and around Boston.  Their insurance expense went up 30% - 5% due to a rate increase and 25% due to higher insured value of buildings.  The higher insured value drives demand for more insurance, and hence in this example, the insurance industry has to set aside 25% more capital to insure these guys.  So if this is replicated across the industry, then this could keep upward pressure on rates.  

On the supply side, according to Renaissance, they have not seen additional capital enter.  Meanwhile, ACGL just announced a 5% special dividend.  So it seems the industry is staying discipled.  By the way, Tom Gayner of Markel bought around $200k worth of Markel stock in the past two weeks - another insider who is bullish.  Everest (EG) just saw a director buy USD 1MM worth of stock.  

So industry insiders are bullish, time will tell whether they are correct or not.  

[SafetyinNumbers]

1 hour ago, Hoodlum said:

 

I just don't think we fully understand where the market may go throughout next year.  We just need to wait and see.

 

I'm not sure it matters much for near term ROE but it could impact capital allocation decisions.

 

If the market hardens then Fairfax might slow buybacks especially if the P/B multiple is expanding. If the market is softening then Fairfax might have more cash for buybacks or to buy in the minority interests. This year they slowed premium growth to buyback stock. I think strategically to get ahead of the 60 add.

 

 

[UK]

5 hours ago, Dinar said:

Here is an interesting anecdote.  I have an investment in a company that owns several dozen apartment buildings in and around Boston.  Their insurance expense went up 30% - 5% due to a rate increase and 25% due to higher insured value of buildings.  The higher insured value drives demand for more insurance, and hence in this example, the insurance industry has to set aside 25% more capital to insure these guys.  So if this is replicated across the industry, then this could keep upward pressure on rates.  

On the supply side, according to Renaissance, they have not seen additional capital enter.  Meanwhile, ACGL just announced a 5% special dividend.  So it seems the industry is staying discipled.  By the way, Tom Gayner of Markel bought around $200k worth of Markel stock in the past two weeks - another insider who is bullish.  Everest (EG) just saw a director buy USD 1MM worth of stock.  

So industry insiders are bullish, time will tell whether they are correct or not.  

 

And I would add, that despite all the mistery of Buffett selling stocks off and going to cash, insurance I think was was the only noticible thing he added to in the last year or so.

[Haryana]

On 11/11/2024 at 4:16 AM, SafetyinNumbers said:

1. When they have the cash to buyback the shares. My guess is when they sell some Digit. Likely years away.

...

Why do you think they will sell some Digit which is part of their global insurance as they never like to sell any of them unless they are forced by the regulation or reach upper limit?

[SafetyinNumbers]

3 hours ago, Haryana said:

Why do you think they will sell some Digit which is part of their global insurance as they never like to sell any of them unless they are forced by the regulation or reach upper limit?

I’m not sure it’s core. 

[giulio]

I am of the opposite view. Given how hard they worked to set it up, the difficult regulatory environment and their long term view of India, I believe they will hold on to shares for a long time.

They might sell some if valuation gets truly outrageous but they'll keep a majority.

Possibly they will increase their stake if allowed to.

 

Best,

G

[SafetyinNumbers]

19 minutes ago, giulio said:

I am of the opposite view. Given how hard they worked to set it up, the difficult regulatory environment and their long term view of India, I believe they will hold on to shares for a long time.

They might sell some if valuation gets truly outrageous but they'll keep a majority.

Possibly they will increase their stake if allowed to.

 

Best,

G

I think they will also hold Digit for a long time. I also think they will hold the TRS for a long time.

[TwoCitiesCapital]

28 minutes ago, giulio said:

I am of the opposite view. Given how hard they worked to set it up, the difficult regulatory environment and their long term view of India, I believe they will hold on to shares for a long time.

They might sell some if valuation gets truly outrageous but they'll keep a majority.

Possibly they will increase their stake if allowed to.

 

Best,

G

 

My hope would be similar to my hope for Exor and their Ferrari position. I don't necessarily want Exor to sell Ferrari when Ferrari's valuation is stupidly high. I want Exor to exert its majority control to compel Ferrari to issue shares/capital at those levels.

 

It's not as clean as a share sale and probably doesn't lock in as much of the upside, but it avoids taxes, maintains a control position (assuming you don't get diluted too much), and puts in a higher-floor for the Ferrari shares while giving them balance sheet flexibility. 

 

I would hope the same for Fairfax/Digit until the market is more mature. 

[Xerxes]

1 hour ago, TwoCitiesCapital said:

 

My hope would be similar to my hope for Exor and their Ferrari position. I don't necessarily want Exor to sell Ferrari when Ferrari's valuation is stupidly high. I want Exor to exert its majority control to compel Ferrari to issue shares/capital at those levels.

 

It's not as clean as a share sale and probably doesn't lock in as much of the upside, but it avoids taxes, maintains a control position (assuming you don't get diluted too much), and puts in a higher-floor for the Ferrari shares while giving them balance sheet flexibility. 

 

I would hope the same for Fairfax/Digit until the market is more mature. 

On EXOR and Ferrari, isn’t Ferrari issuing shares anti-thesis to the scarcity of their formidable brand and their commanding position. 

[TwoCitiesCapital]

21 minutes ago, Xerxes said:

On EXOR and Ferrari, isn’t Ferrari issuing shares anti-thesis to the scarcity of their formidable brand and their commanding position. 

 

The value is in the scarcity of their cars. 

 

If people bid up the shares, issue shares to meet the demand. Buy them back opportunistically. 

 

Is a better solution than selling the shares, paying taxes, and losing control of irreplaceable asset. 

Edited November 13, 2024 by TwoCitiesCapital

[Hoodlum]

It looks like Paul Rivett is getting involved with and insurance startup.

 

https://www.insurancebusinessmag.com/ca/news/mergers-acquisitions/western-investment-company-announces-strategic-shift-to-insurance-513872.aspx

 

Western has also forged a partnership with Paul Rivett, former president of Fairfax Financial, renowned for his expertise in value-based float management. Tannas believes Rivett’s experience will support the company’s aim to integrate insurance underwriting with conservative float management, which is anticipated to provide stable, compounded returns.

 

“Float management seems antithetical to most insurance companies,” Tannas noted. “Given their enormous success, it’s puzzling that only a handful of people see that these two separate activities – insurance underwriting and float management – belong in one business. While at Fairfax, Paul was at the center of this approach and their value investing philosophy. He has seen it, knows it, lived it, and succeeded at it.”

Edited November 14, 2024 by Hoodlum

[Viking]

Excess of FV over CV - Are you paying attention?

 

EPS, BVPS, ROE and Calculating Intrinsic Value

 

Successful investing is centred around properly calculating the intrinsic value of a company. This involves properly estimating the cash flows of the business - past, present and future. Do only accounting cash flows matter? With a little help from Warren Buffett, that is the question we will try and answer in this post.

 

For Fairfax, annual EPS and the change in BVPS provides an incomplete picture of the growth in intrinsic value that is happening at the company. We need to supplement these important performance measures with other sources. Fortunately, Fairfax helps investors do this with their communication and some of their additional disclosures.

 

Having an information advantage is a wonderful way to make money

 

One of the easiest way to outperform other investors is to have an information advantage over them. It is like taking candy from a baby.

 

But markets are efficient… right? Everything that is know about a company - at any point in time - is priced into its share price. Or at least that is how the story goes. Right?

 

Of course, that is complete garbage. Especially for under-followed, misunderstood and under appreciated companies. Like Fairfax.

 

The really interesting thing is Fairfax has been doing a very good job of trying to help investors understand the company. But despite Fairfax’s best efforts, many investors do not seem to be paying attention. As a result, many investors do not have an accurate grasp on the economic results that Fairfax has been delivering - they are underestimating Fairfax’s past performance (the cash flows it has delivered). And this is causing them to underestimate Fairfax’s future performance (and cash flows), leading them to undervalue the company.

 

What are we talking about?

 

Read on grasshopper…

 

How to value a P/C insurance company

 

Investors are taught that the correct way to value a P/C insurance company is to focus on two metrics:

 

1.) ROE - How much is the company earning?

• ROE = EPS / (average) BVPS

2.) P/BV - What does Mr. Market expect earnings to be in the future?

• P/BV = Stock price / BV

Because it feeds into both ROE and BVPS, annual EPS is the key input to both metrics. The one year change in EPS is generally what drives the one year change in book value. And the one year change in book value is used as a rough approximation for the change in intrinsic value. Easy peasy.

 

Annual EPS, which feeds ROE, is also a good measure of the performance of the management team.

 

This approach (centred on ROE and P/BV) works well for most P/C insurance companies. And that is because most P/C insurance companies hold mostly bonds in their investment portfolio. And bonds are very easy to value. Therefore, BVPS is a solid tool to use to calculate intrinsic value. And the annual change in BVPS is a good measure of how the management team is performing.

 

Over time, for most P/C insurance companies the annual change in accounting value tends to be highly correlated with the change in economic value.

 

This works for most P/C insurance companies. But not for some. Like Berkshire Hathaway. Markel. And increasingly, Fairfax.

 

What is so special about Berkshire Hathaway, Markel and Fairfax?

 

These three companies do not invest their investment portfolios primarily in bonds. They invest a significant amount of their investment portfolio in equities.

 

But we need to make a distinction here. Publicly traded stocks (that are market to market accounted) are not the issue. Yes, publicly traded stocks are volatile. But over time, Mr. Market tends to value publicly traded stocks properly. So for publicly traded mark to market stocks the change in value over time will get reflected in EPS and BVPS for companies like BRK, MKL and FFH.   

 

The issue lies with associate and consolidated equity holdings. Because of how accounting works, the economic/intrinsic value of these holdings can diverge greatly from their accounting value (the 'carry value' which is what is what is captured in book value). Over time the divergence can become very large.

 

The net result is annual EPS chronically understates the annual increase in economic/intrinsic value that is happening at the company. EPS feeds BVPS. Over time, BVPS diverges more and more from the economic/intrinsic value of the company. As a result, BVPS eventually becomes a poor tool to use to value a company.

 

And that is what happened at Berkshire Hathaway.

 

What was Warren Buffett’s solution?

 

In the 2018 annual report, Buffett banished book value from existence at Berkshire Hathaway.

 

It was a seismic event for Berkshire Hathaway shareholders. They had been trained for 53 years by Buffett to worship at the alter of book value. And in 2018… poof… it was gone.

 

Why would Buffett do this?

 

Because it was important. Really important.

 

Book value had ‘lost the relevance it once had’ as a tool for investors to use to value Berkshire Hathaway. Buffett did it to help investors.

 

Here is what Buffett had to say in Berkshire Hathaway’s 2018AR:

 

“Long-time readers of our annual reports will have spotted the different way in which I opened this letter. For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice.

 

“The fact is that the annual change in Berkshire’s book value – which makes its farewell appearance on page 2 – is a metric that has lost the relevance it once had. Three circumstances have made that so.

• First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner.
• Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years.
• Third, it is likely that – over time – Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality.”

What does this have to do with Fairfax?

 

What has Fairfax been doing over the past 5 years?

 

Fairfax has been rapidly growing out its collection of associate/consolidated equity holdings, with Sleep Country being the most recent example. Fairfax has more than $20 billion in equity investments and more than $10 billion are now associate/consolidated holdings.

 

Importantly, the economic value of these holdings is diverging from their accounting or ‘carrying value.’ This divergence has been increasing in size in recent years. This is creating an EPS and book value informational problem for Fairfax investors - increasingly, EPS and book value is not telling investors what they think it is.

 

Fairfax is trying to help investors

 

Unlike Berkshire Hathaway, Fairfax has not (yet) decided to throw out book value.

 

When Fairfax reports results each quarter they do report book value. But they also report another item: ‘excess (deficiency) of fair value over adjusted carrying value’ for their non-insurance associate and consolidated equity holdings.

 

In their quarterly/interim and annual reports Fairfax report these two items together in the ‘Book Value Per Basic Share’ section of the reports.

 

Why does Fairfax report the two items together?

 

This is also important.

 

Fairfax is trying to educate and inform investors - give them the information they need to properly value the company and to evaluate the management team.

 

They are telling investors loud and clear that if they want to properly evaluate management’s performance they need to consider two things each year:

1. The change in BVPS (adjusted for dividends paid).
2. The change in excess of FV over CV for non-insurance associate and consolidated equity holdings.

 

But don’t take my word for it. Here is what Fairfax had to say in their Q3, 2024 interim report.

 

“The table below presents the pre-tax excess (deficiency) of fair value over adjusted carrying value of investments in non-insurance associates and market traded consolidated non-insurance subsidiaries the company considers to be portfolio investments. Those amounts, while not included in the calculation of book value per basic share, are regularly reviewed by management as an indicator of investment performance.” Fairfax Q3 Interim Earnings Report

 

Fairfax is providing a roadmap for investors. Of course, investors need to actually use the roadmap for it to be of value.   

 

What do the numbers tell us?

 

At September 30, 2024, the excess of FV over CV was $1.9 billion or $87/share (pre-tax). Over the past 3.75 years, the excess of FV over CV has increased by an average of $689 million per year. This is a significant amount of value creation over 4 years that did not show up in EPS or book value. This means it also does not show up in ROE.

 

Is this important? I think it is. A lot. 
 

Let’s try and fold this in to EPS and ROE.

 

We can break the numbers down by year and apply a tax rate (we use 25%). This allows us to make an ‘adjusted’ estimate for EPS, BVPS and ROE that includes ‘excess of FV over CV’. Our goal is to use the information provided by Fairfax to:

1. Better understand the change in the intrinsic value of the company.
2. Better evaluate the performance of the management team.   

What do we learn?

 

As measured by ‘excess of FV over CV’, over the past 4 years, Fairfax has created additional value for shareholders of about $20/share per year (after -tax). This boosts ROE by about 2.5% per year. This is a meaningful increase.

 

Bottom line, the management team has been doing much better than the reported numbers suggest. (And the reported numbers already suggest that have been doing an exceptional job in recent years).

 

What will happen moving forward?

 

I am in process of updated my earnings estimates for Fairfax for 2024 and 2025 (so the numbers I use below might change a little).

 

For 2024, I adjusted ‘excess of FV to CV’ down from its current value of $1.9 billion to $1.6 billion to reflect the sale of Stelco. For 2025, I estimate ‘excess of FV over CV’ will increase about $300 million = $10/share.

 

If my estimates for 2024 and 2025 are accurate, for the 5-year period from 2021 to 2025, adjusted ROE at Fairfax will average about 19% per year. That is exceptional performance over a 5-year period. Fairfax’s stock continues to trade at a valuation multiple (you pick whatever one you want to use) that is well below that of peers. Does that make any sense?

 

Importantly, Fairfax’s management team is executing exceptionally well. And Fairfax’s prospects have rarely looked better.

  

 

An important source of future investment gains

 

‘Excess of FV over CV’ will be a source of significant investment gains for Fairfax in the future.

 

Fairfax has many ways of harvesting/monetizing the gains sitting in ‘Excess of FV over CV’.

 

Asset sales. Stelco is a timely example. The deal to sell Stelco to Clevelenad-Cliffs closed on November 1, 2024. At September 30, 2024, the excess of FV over CV for Fairfax’s position in Stelco was $366 million. When Fairfax reports Q4 results, they will book an investment gain of $366 million from the sale of Stelco.

 

Asset re-valuations. Sometimes Fairfax will change its ownership stake in an associate or consolidated holdings and this will usually trigger a revaluation of the carrying value of the asset (to the new value). This is what will likely happen with Peak Achievement when it closes in Q4 (Fairfax bought out its majority partner).

 

Importantly, in the coming years, the significant amount of value residing (hiding?) in ‘excess of FV over CV’ should supply a steady stream of investment gains for Fairfax. We can be pretty certain that sizeable gains are coming. We just don’t know the amount and the timing. When they do get recognized, like with Stelco in Q4, 2024, they will flow through the accounting statements and provide a nice bump to EPS, BVPS and ROE.

 

Importantly, the coming investment gains from ‘excess of FV over CV’ are not currently built into analyst estimates. Like Stelco, these gains will be ’surprise’ gains.

 

Per share

 

(Hat tip to @Hamburg Investor for pointing this out.)

 

Buffett teaches us that absolute numbers (earnings, book value, investment portfolio, float) are not what really matters. What really matters to shareholders is the growth in the per share numbers over time. 
 

Over the past 3.75 years, Fairfax has reduced effective shares outstanding from 26.2 million at Dec 31, 2020, to 22.0 million at Sept 30, 2024. This is a reduction of 4.2 million shares or 16%. 
 

So when it comes to ‘excess of FV over CV’, over the past 3.75 years, Fairfax shareholders have benefitted in two ways:

1. Via the $2.6 billion increase in the value of ‘excess of FV over CV’ 
2. Via the 16% reduction in effective shares outstanding - this boosts the per share benefit even more.

 

'One more thing'

‘Excess of FV over CV’ is just one example of how Fairfax is building value for shareholders with its equity holdings in a way that is not captured by EPS and book value. There are more examples. Like what? 

 

The fair value for some of Fairfax’s associate and consolidated equity holdings look like they are materially understated. The best example of this is Fairfax India with a FV of $856.8 million. The FV is calculated using the stock price of Fairfax India ($15.07) at September 30, 2024. If FV was instead calculated using the BVPS of Fairfax India ($21.67/share) it would be $1.25 billion. That is a $400 million gap. And for Fairfax India, intrinsic value is likely much higher than BVPS.

 

The bottom line is the quality of the equity portfolio at Fairfax (in terms of management and earnings power) has never been better. The equity portfolio is generating significant value for Fairfax and its shareholders. However, a significant amount of the value creation is not showing up in reported EPS and BV.
 

Learning the lesson of missing the big money with Berkshire Hathaway

 

I have followed Berkshire Hathaway for decades. I understood the amazing abilities of Warren Buffett. And i understood the value of the P/C insurance model (float and equities).

 

How much money did i make from my ‘knowledge’? 
 

Very little. Especially compared to what Berkshire Hathaway delivered to its shareholders. 
 

What was my big miss? 
 

I was focussed on accounting value. And i completely missed the economic value that was being generated each year, primarily by Berkshire Hathaway’s equity holdings. The economic value being created each year was much larger than the accounting value. And over the years this ‘excess value’ compounded.
 

I thought i understood Warren Buffett and Berkshire Hathaway. I did not. My ignorance cost me dearly - it caused me to missed out on making the big money. 
 

I am determined to not let this happen a second time - this time with Fairfax. 

 

Conclusion

 

For P/C insurance companies, reported EPS, BVPS and ROE are important metrics to use to calculate intrinsic value and to evaluate the performance of the management team. However, for a company like Fairfax, these measures are incomplete.

 

The standard tools need to be supplemented with an additional tools, one of which Fairfax provides for investors: the ‘excess of FV over CV’ for associate and consolidated holdings.

 

Fairfax is doing their best to help investors. They make it easy. But as the old saying goes… “You can lead a horse to water, but you can’t make it drink.”

 

So the next time you talk to someone about Fairfax ask them if they are incorporating ‘excess of FV over CV’ into their analysis of the company, especially their future EPS estimates. My guess is they won’t know what you are talking about. And that probably tells you something about how well they understand the company.

 

————

 

Excess of Fair Value over Carrying Value

 

Below are details of Fairfax’s associate and consolidated holdings. And the change in value over each of the past 4 years.

 

Key take aways:

• Over the past 3.75 years, the fair value has increased from $4.3 billion to $10.1 billion, or a total of 135%, which is a CAGR of 25.6%. That is significant growth.
• Excess of FV over CV has increased $2.6 billion, from a deficiency of $663 million at December 31, 2020, to an excess of $1.9 billion at Sept 30, 2024.
• Excess of FV over CV has increased by an average of $689 million per year over the past 3.75 years. This is an average of $27/share (pre tax).

 

 

Edited November 15, 2024 by Viking

[73 Reds]

11 minutes ago, Viking said:

Excess of FV over CV - Are you paying attention?

 

EPS, BVPS, ROE and Calculating Intrinsic Value

 

Successful investing is centred around properly calculating the intrinsic value of a company. This involves properly estimating the cash flows of the business - past, present and future. Do only accounting cash flows matter? With a little help from Warren Buffett, that is the question we will try and answer in this post.

 

For Fairfax, the annual change in EPS provides an incomplete picture of the growth in intrinsic value. We need to supplement EPS with other sources. Fortunately, Fairfax helps out investors with some of their additional disclosures.

 

Having an information advantage is a wonderful way to make money

 

One of the easiest way to outperform other investors is to have an information advantage over them. It is like taking candy from a baby.

 

But markets are efficient… right? Everything that is know about a company - at any point in time - is priced into its share price. Or at least that is how the story goes. Right?

 

Of course, that is complete garbage. Especially for under-followed, misunderstood and under appreciated companies. Like Fairfax.

 

The really interesting thing is Fairfax has been doing a very good job of trying to help investors understand the company. But despite Fairfax’s best efforts, many investors do not seem to be paying attention. As a result, many investors do not have an accurate grasp on the economic results that Fairfax has been delivering - they are underestimating Fairfax’s past performance (the cash flows it has delivered). And this is causing them to underestimate Fairfax’s future performance (and cash flows), leading them to undervalue the company.

 

What are we talking about?

 

Read on grasshopper…

 

How to value a P/C insurance company

 

Investors are taught that the correct way to value a P/C insurance company is to focus on two metrics:

 

1.) ROE - How much is the company earning?

• ROE = EPS / (average) BVPS

2.) P/BV - What does Mr. Market expect earnings to be in the future?

• P/BV = Stock price / BV

Because it feeds into both ROE and BVPS, annual EPS is the key input to both metrics. The one year change in EPS is generally what drives the one year change in book value. And the one year change in book value is used as a rough approximation for the change in intrinsic value. Easy peasy.

 

Annual EPS, which feeds ROE, is also a good measure of the performance of the management team.

 

This approach (centred on ROE and P/BV) works well for most P/C insurance companies. And that is because most P/C insurance companies hold mostly bonds in their investment portfolio. And bonds are very easy to value. Therefore, BVPS is a solid tool to use to calculate intrinsic value. And the annual change in BVPS is a good measure of how the management team is performing.

 

Over time, for most P/C insurance companies the annual change in accounting value tends to be highly correlated with the change in economic value.

 

This works for most P/C insurance companies. But not for some. Like Berkshire Hathaway. Markel. And increasingly, Fairfax.

 

Why is this?

 

These three companies do not invest their investment portfolios primarily in bonds. They invest a significant amount of their investment portfolio in equities.

 

But we need to make a distinction here. Publicly traded stocks (that are market to market accounted) are not the issue. Yes, publicly traded stocks are volatile. But over time, Mr. Market tends to value publicly traded stocks properly. So for publicly traded mark to market stocks the change in value over time will get reflected in EPS and BVPS for companies like BRK, MKL and FFH.   

 

The issue lies with associate and consolidated equity holdings. Because of how accounting works, the economic/intrinsic value of these holdings can diverge greatly from their carry value (which is what is captured in book value). Over time the divergence can become very large.

 

The net result is annual EPS chronically understates the annual increase in economic/intrinsic value that is happening at the company. EPS feeds BVPS. Over time, BVPS diverges more and more from the economic/intrinsic value of the company. As a result, BVPS eventually becomes a poor tool to use to value a company.

 

And that is what happened at Berkshire Hathaway.

 

What was Warren Buffett’s solution?

 

In the 2018 annual report, Buffett banished book value from existence at Berkshire Hathaway.

 

It was a seismic event for Berkshire Hathaway shareholders. They had been trained for 53 years by Buffett to worship at the alter of book value. And in 2018… poof… it was gone.

 

What would Buffett do this?

 

Because it was important. Really important.

 

Book value had ‘lost the relevance it once had’ for investors to use to value Berkshire Hathaway. Buffett did it to help investors.

 

Here is what Buffett had to say in Berkshire Hathaway’s 2018AR:

 

“Long-time readers of our annual reports will have spotted the different way in which I opened this letter. For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice.

 

“The fact is that the annual change in Berkshire’s book value – which makes its farewell appearance on page 2 – is a metric that has lost the relevance it once had. Three circumstances have made that so.

• First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner.
• Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years.
• Third, it is likely that – over time – Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality.”

What does this have to do with Fairfax?

 

What has Fairfax been doing over the past 5 years?

 

Fairfax has been rapidly growing out its collection of associate/consolidated equity holdings, with Sleep Country being the most recent example. Fairfax has more than $20 billion in equity investments and more than $10 billion are now associate/consolidated holdings.

 

Importantly, the economic value of these holdings is diverging from their account or ‘carrying value.’ This divergence has been increasing in size in recent years. This is creating a book value informational problem for Fairfax investors - increasingly, book value is not telling investors what they think it is.

 

Fairfax is trying to help investors

 

Unlike Berkshire Hathaway, Fairfax has not (yet) decided to throw out book value.

 

When Fairfax reports results each quarter they do report book value. But they also report another item: ‘excess (deficiency) of fair value over adjusted carrying value’ for their non-insurance associate and consolidated equity holdings.

 

In their quarterly/interim and annual reports they report these two items together in the ‘Book Value Per Basic Share’ section of the reports.

 

Why does Fairfax report the two items together?

 

This is important.

 

Fairfax is trying to educate and inform investors - give them the information they need to properly value the company and evaluate the management team.

 

They are telling investors loud and clear that if they want to properly evaluate management’s performance they need to consider two things each year:

1.) The change in BVPS (adjusted for dividends paid).

2.) The change in excess of FV over CV for non-insurance associate and consolidated equity holdings.

 

But don’t take my word for it. Here is what Fairfax has to say.

 

“The table below presents the pre-tax excess (deficiency) of fair value over adjusted carrying value of investments in non-insurance associates and market traded consolidated non-insurance subsidiaries the company considers to be portfolio investments. Those amounts, while not included in the calculation of book value per basic share, are regularly reviewed by management as an indicator of investment performance.” Fairfax Q3 Interim Earnings Report

 

Fairfax is providing a roadmap for investors. Of course, investors need to actually use the roadmap for it to be of value.   

 

 

What do the numbers tell us?

 

At September 30, 2024, the excess of FV over CV was $1.9 billion or $87/share (pre-tax). This is value that has been created but has not yet been captured in EPS or BVPS. This means it also does not show up in ROE.

 

We can break the numbers down by year and apply a tax rate (we use 25%). This allows us to make an ‘adjusted’ estimate for EPS, BVPS and ROE that includes ‘excess of FV over CV’. Our goal is to use the information provided by Fairfax to:

1. Better understand the change in the intrinsic value of the company.
2. Better evaluate the performance of the management team.   

What do we learn?

 

As measured by ‘excess of FV over CV’, over the past 4 years, Fairfax has created additional value for shareholders of about $20/share per year (after -tax). This boosts ROE by about 2.5% per year. This is a meaningful increase.

 

Bottom line, the management team has been doing much better than the reported numbers suggest. (And the reported numbers already suggest that have been doing an exceptional job in recent years).

 

What will happen moving forward?

 

I am in process of updated my earnings estimates for Fairfax for 2024 and 2025 (so the numbers I use below might change a little).

 

For 2024, I adjusted ‘excess of FV to CV’ down from its current value of $1.9 billion to $1.6 billion to reflect the sale of Stelco. For 2025, I estimate ‘excess of FV over CV’ will increase about $300 million = $10/share.

 

If my estimates for 2024 and 2025 are accurate, for the 5-year period from 2021 to 2025, adjusted ROE at Fairfax will average about 19% per year. That is exceptional. Fairfax’s stock continues to trade at a valuation multiple (you pick whatever one you want to use) that is well below that of peers. Does that make any sense?

 

Importantly, Fairfax’s management team is executing exceptionally well. And Fairfax’s prospects have rarely looked better.

  

 

An important source of future investment gains

 

Excess of FV over CV will be a source of significant investment gains for Fairfax in the future.

 

Fairfax has many ways of harvesting/monetizing the gains sitting in ‘excess of FV over CV’.

 

Asset sales. Stelco is a timely example. The deal to sell Stelco to Clevelenad-Cliffs closed on November 1, 2024. At September 30, 2024, the excess of FV over CV for Fairfax’s position in Stelco was $366 million. When Fairfax reports Q4 results, they will book an investment gain of $366 million from the sale of Stelco.

 

Asset re-valuations. Sometimes Fairfax will change its ownership stake in an associate or consolidated holdings and this will usually trigger a revaluation of the carrying value of the asset (to the new value). This is what will likely happen with Peak Achievement when it closes in Q4 (Fairfax bought out its majority partner).

 

Importantly, in the coming years, the significant amount of value residing (hiding?) in ‘excess of FV over CV’ should supply a steady stream of investment gains for Fairfax. We can be pretty certain that sizeable gains are coming. We just don’t know the amount and the timing. When they do get recognized, like with Stelco in Q4, 2024, they will flow through the accounting statements and provide a nice bump to EPS, BVPS and ROE.

 

Importantly, the coming investment gains from ‘excess of FV over CV’ are not currently built into analyst estimates. Like Stelco, these gains will be ’surprise’ gains.

 

One more wrinkle

 

The fair value for some of Fairfax’s associate and consolidated equity holdings look like they are materially understated. The best example of this is Fairfax India with a FV of $856.8 million. The FV is calculated using the stock price of Fairfax India ($15.07) at September 30, 2024. If it used the BVPS of Fairfax India it would be $1.25 billion ($21.67). That is a $400 million gap. And for Fairfax India, intrinsic value is much higher than BVPS.

 

The bottom line, this is just another example of how significant value is hiding - unrecognized in the financial statements - in Fairfax’s collection of associate and consolidated equity holdings.

 

Conclusion

 

For P/C insurance companies, EPS, BVPS and ROE are important metrics to use to calculate intrinsic value and to evaluate the performance of the management team. However, for a company like Fairfax, these measures are incomplete.

 

The standard tools need to be supplemented with an additional tool, which Fairfax provides for investors: the ‘excess of FV over CV’ for associate and consolidated holdings.

 

Fairfax is doing their best to help investors. They make it easy. But as the old saying goes… “You can lead a horse to water, but you can’t make it drink.”

 

So the next time you talk to someone about Fairfax ask them if they are incorporating ‘excess of FV over CV’ into their analysis of the company. My guess is they won’t know what you are talking about. And that probably tells you something about how well they understand the company.

 

————

 

Excess of Fair Value over Carrying Value

 

Below are details of Fairfax’s associate and consolidated holdings. And the change in value over each of the past 4 years.

 

Key take aways:

• Over the past 3.75 years, the fair value has increased from $4.3 billion to $10.1 billion, or a total of 135%, which is a CAGR of 25.6%. That is significant growth.
• Excess of FV over CV has increased $2.6 billion, from a deficiency of $663 million to a excess of $1.9 billion at Sept 30, 2024.
• Excess of FV over CV has increased by an average of $689 million per year over the past 3.75 years. This is an average of $27/share (pre tax).

 

Thanks for the nice explanation, Viking.  Perhaps someone will convince Warren or future management to do the same for BRK.

[Viking]

1 hour ago, 73 Reds said:

Thanks for the nice explanation, Viking.  Perhaps someone will convince Warren or future management to do the same for BRK.

@73 Reds , as i do my deep dives on Fairfax it is helping me get to the core of value creation. With a large equity portfolio there are so many ways value is created - but much of it is not captured in real time by the accounting models (EPS and BVPS). This was likely the biggest reason why i missed out on the big gains in BRK 20 years ago - I did not understand all the value that was building (and compounding) in the equity holdings that was not showing up in the reported results. 
 

One of the things i like about Fairfax is they do have a habit of surfacing this value. This makes it easier for investors to understand what is going on under the hood. 
 

Having said all that, there is still a lot that we don’t understand:

- Depsite its big run the past 4 years, Eurobank still looks very undervalued. 

- What is Poseidon worth today? My guess is it is worth much more than its reported CV. 
- What is BIAL worth today?
- How is Grivalia Hospitality doing? It is an asset play, not an earnings play. And property prices in Greece have spiked higher for years.

- What is AGT Food Ingredients worth?
- I could go on. 

Fairfax also has a large amount (well over $1.5 billion) invested with private equity shops like BDT, Shaw Kwei, JAB Holdings etc. They are reported as mark to market but they really are not. My guess is there is a significant amount of value residing on the balance sheets of those companies that is waiting to be harvested in the coming years.
 

Bottom line, BVPS at Fairfax is likely much more understated than investors realize. The other way to think about that is reported earnings for Fairfax over the past 4 years has been materially understating the value that is being created by the company. This will become apparent in the coming years as these hidden gains get harvested. Lots of investors will say … ‘Who could have possibly known?’

 

Patience really is probably the most important trait to have to be a successful investor… (Unfortunately that is not my strength. @dealraker is my role model in this regard). 

Edited November 14, 2024 by Viking

[dealraker]

19 minutes ago, Viking said:

@73 Reds , as i do my deep dives on Fairfax it is helping me get to the core of value creation. With a large equity portfolio there are so many ways value is created - but much of it is not captured in real time by the accounting models (EPS and BVPS). This was likely the biggest reason why i missed out on the big gains in BRK 20 years ago - I did not understand all the value that was building (and compounding) in the equity holdings that was not showing up in the reported results. 
 

One of the things i like about Fairfax is they do have a habit of surfacing this value. This makes it easier for investors to understand what is going on under the hood. 
 

Having said all that, there is still a lot that we don’t understand:

- Depsite its big run the past 4 years, Eurobank still looks very undervalued. 

- What is Poseidon worth today? My guess is it is worth much more than its reported CV. 
- What is BIAL worth today?
- How is Grivalia Hospitality doing? It is an asset play, not an earnings play. And property prices in Greece have spiked higher for years.

- What is AGT Food Ingredients worth?
- I could go on. 

Fairfax also has a large amount (well over $1.5 billion) invested with private equity shops like BDT, Shaw Kwei, JAB Holdings etc. They are reported as mark to market but they really are not. My guess is there is a significant amount of value residing on the balance sheets of those companies that is waiting to be harvested in the coming years.
 

Bottom line, BVPS at Fairfax is likely much more understated than investors realize. The other way to think about that is reported earnings for Fairfax over the past 4 years has been materially understating the value that is being created by the company. This will become apparent in the coming years as these hidden gains get harvested. Lots of investors will say … ‘Who could have possibly known?’

 

Patience really is probably the most important trait to have to be a successful investor… (Unfortunately that is not my strength. @dealraker is my role model in this regard). 

Viking I've been part of a few different forums and groups over the decades in my journey of being interested in and owning things like - and maybe expecially Fairfax given it has now (price wise) roared back to life.  The nice thing about your leadership of this thread is that it isn't like "oh...this is my idea and never before did anyone ever..." and so forth.  You did lots of work and you just put it out while stating your case.  For a long time I was a loner-owner, nowhere could I find others to share discussion about Fairfax.  

 

It is hard to relay without seemingly projecting some arrogance as to how much I have enjoyed the experience of long term investing - again in things outliers like Fairfax that most typical investment types would never feel good sticking with or making the gap to grasp how it works. 

 

I'm a tad different than you as how I go about the insurance business.  I basically choose managements that I think are the Labron James' of the business, better and more able to keep outperforming, and I roll right on through the bad periods.  Interestingly, and I know you are fully aware, a few of Berkshire's insurance areas are having a tough go of it, Geico being left miles behind Progressive...

 

So the story of Fairfax is one where I felt it inevitable of the comeback.  As usual, as a long term owner, I'm quite happy with Fairfax's valuation whether high or low as to our intrinsic model.  There's always choices that can be made based on the price-to-value.  I don't expect full or over-valuation to come often, and if it does it will be very brief.

 

Have a good day.   

[roundball100]

1 hour ago, dealraker said:

... I basically choose managements that I think are the Labron James' of the business, better and more able to keep outperforming ...

LeBron just recorded another triple-double, his third straight, becoming the oldest player (he's now 39) to record three straight triple doubles.  Keeps setting more records as he gets older --- which is what Viking has been telling us about Fairfax for quite some time now.

[dealraker]

40 minutes ago, roundball100 said:

LeBron just recorded another triple-double, his third straight, becoming the oldest player (he's now 39) to record three straight triple doubles.  Keeps setting more records as he gets older --- which is what Viking has been telling us about Fairfax for quite some time now.

Yea roundball I just heard that a few 38 year old NBA players had scored 30 just one time while LJ is already over 30 times headed to 100.  LOL.